1

Session 9

Make or Buy Decisions

Vikram D. Shikhare

2

Make or Buy - rationale Scope Functional analysis Technological dimensions Factor analysis Quantitative techniques

OBJECTIVES

3

IntroductionProduction of all parts and components of

main equipment is uneconomical and infeasible.

Production economy and competitive costing is possible by using modern technology and high volume capacity.

Only critical parts / components may be produced in-house.

4

Introduction (Continued) Plant capacity is limited to take care of captive

requirements only

In general it is economical to set up a production

capacity based on horizontal integration.

Manufacture concentrates on technology

production and sales and procures the rest from

sub-contractors.

All units are engaged in make or buy decisions.

5

Make OR Buy Decision Factors considered in Making a component

– Location, Layout, capacity, product and process technology, plant and machinery, facilities, production control, quality and maintenance aspects

Factors considered in Buying a component – What, How, How Much, When, Where and What price?

Commonsense approach / in-depth analysis.

Data must be available to analyse.

6

Make OR Buy Decision Techniques available –

– Decision tree– Break-even analysis

When data is not fully available– Statistical techniques – forecasting, trend

analysis, regression techniques.

No analysis can substitute managerial capability and skill

7

Scope Covers all resources –

– Materials and components– Manufacturing capacity– Infrastructure facilities– Manpower skills– Maintenance– After-Sales service

8

Functional analysis Make or Buy decisions have short and long

term effects on all functions of the organization –– Financial– Technological– Marketing– Purchasing– Strategic– Intangible aspects

9

Financial aspects Make decision requires certain financial

investments – – Fixed costs– Variable costs

Buy decision has only variable costs All benefits can be converted to financial

terms and analyzed. Many techniques available

10

Technological Aspects Technological dimensions –

a) Accessibility – Latest technology – IC circuits – have to be bought.

b) Exclusive Technology – technology transfer agreements - manufacturer has to set up a plant.

c) Non-exclusive technology - Manufacturer has an option

11

Technological Aspectscontinued

d) Technological obsolescence - Manufacturers are reluctant to invest and set up a plant. It is prudent to buy – design flexible for upgradation to new technology.

e) Product Life cycle – Product growth stage or at maturity – set up capacity to manufacture critical components to reduce cost and improve competitiveness. At declining stage – buy components.

12

Marketing Aspects Make or Buy decision is dependent on –

a) Competition – In case Severe competition – cost and quality important. Make decision provides reliable supply and better quality however cost increases. Trade-off in decision

b) Market share and potential – In case of larger market share and future potential, make decision is preferred.

13

Marketing Aspectsc) End-User – govt. departments, defense insist on quality and reliability. Manufacturers prefer to invest in plant and equipment.

d) Profitability – either cut costs or improve sales price and volume. Price in competitive market can be increased only by improved quality / additional features in product. An in-house set up is preferable.

14

Purchasing Aspects Option to buy depends on -

– Availability in right quantity at right time– Acceptable quality and price levels

Time and Quantity –– Delay in delivery causes production hold-ups.

Early deliveries causes increased cost of carrying inventory.

– Concept of JIT Quality and Price Levels – Quality and

price are related in practice. The objective of Buy decision will not be realised unless we receive right quality at right price.

15

Strategic aspects Make or Buy decisions affect Long and

Short term plans of business –

a) Maintaining the aim – Objectives of business must be clearly defined and followed. Any diversion from plan will result in objective not being fulfilled.

b) Economy of effort – Unwise to distribute resources over wide area. Judicious selection of Make or Buy items is necessary.

16

Strategic aspects

c) Flexibility – As future is uncertain a flexible strategy provides freedom to change the mix of make or buy components.

d) Cooperation – Between manufacturers and vendors is essential to the success of make-or-buy strategy with give and take on quantity, price, schedule etc.

17

Strategic aspectse) Offensive strategy – steps taken to achieve market leadership.– Surprise for competitors– Security of one’s own technology

Introduce products of superior technology– Produce in-house or buy from vendors having

better technology / in-house R and D to adopt and innovate superior technology.

Security of technology– Effective steps to deny information to

competitors. Patent regimes.

18

Strategic aspectsf) Self-reliance – to protect self-interest and competitive position it is advisable to make critical components instead of buying.

19

Intangible Aspectsa) Reliability –

of vendors in case of Buy and of Plant and machinery / technology in case of Make

b) Quality –

Applicable to both make or buy decisions.

c) Technical assistance –

In case of make decisions technical assistance must be available from Equipment suppliers / collaborators / consultants

20

Intangible Aspectsd) Environmental Factors –

In case of make decision the products/processes must be compatible with existing manufacturing plant environment in terms of noise, vibration, dust, toxic emissions etc. e) Labour acceptance –

Union / Labour cooperation is vital in case of making of new items and outsourcing

of existing items.f) Goodwill –

with vendors / suppliers / stakeholders influences Make or buy decisions.

21

Factor Analysis Endogenous factors – under control of

organization Exogenous factors – Company does not

have full control

They may be listed in favour of make or buy decisions and their impact evaluated as High , medium and low.

These could be tabulated by the decision making committee.

22

Factor Analysis - Endogenous factors

Sr No Factor Conditions favouring Make

Conditions favouring Buy

1 Volume of Production

High Low

2 Infrastructure Available Not available

3 Manpower Excess Insufficient

4 Fixed cost Low High

5 Profitability High Low

23

Factor Analysis - Exogenous factors

Sr No

Factor Conditions favouring Make

Conditions favouring Buy

1 Collaboration agreement

Exclusive Non – exclusive

2 Demand of item Long term Short term

3 Reliability of vendors

Unreliable Reliable

4 Standard items No Yes

5 Labour relations Good Bad

24

Quantitative TechniquesThese can help managers to evaluate the factors influencing the decisions. They have their own limitations.

1. Cost considerations - Break even analysis

2. Cost Volume analysis

3. Profit considerations – Profit volume analysis

4. Use of equal cost chart.

5. Use of Probability

6. Use of decision Tree approach

7. Use of Discounted Cash Flow analysis

8. Use of Net present value method

25

Thank You